Economic Base Model

1. Economic Base Model Pam Perlich UBRPL 5/6020: Urban and Regional Planning Analysis University of Utah

2. Objectives • Illustrate basic concepts via Keynesian Circular Flow Model • Define regional economic base model and terminology • Review economic base estimation methods • Identify some limitations of the model

3. Purpose of the Model • Economic Base Models are used to understand regional economic growth and development. • Analyses from these types of models are used to design, implement, and evaluate economic development policies.

4. Origins of the Model • Urban and regional studies in sociology early in the century • Geography and planning in the 1950s • Economic trade and macro theory in the 1950s

5. Keynes Responds to Classicals • John Maynard Keynes was trying to explain the causes, consequences, and potential policy correctives for the Great Depression • Classical economists had suggested that markets would “self-correct” • Wages, prices, and interest rates would fall to such a low point that purchasing, hiring, and investing would begin again and the economy would take-off

6. Keynesian Critique of Classical Economists • Even if interest rates fall to low levels, businesses will not invest because they do not want to expand capacity during a depression. • They will not hire labor, no matter how low the wages, because there is no need to expand production during a depression. • When people have low wages, they cannot buy products. This reinforces the downward spiral of spending and income in a depression.

7. Injections, withdrawalsand equilibrium Circular Flow Model

8. The circular flow of income Consumption of domestically produced goods and services (Cd)

9. The circular flow of income Consumption of domestically produced goods and services (Cd) Factor payments

10. The circular flow of income Consumption of domestically produced goods and services (Cd) Factor payments BANKS, etc Net saving (S)

11. The circular flow of income Investment (I) Consumption of domestically produced goods and services (Cd) Factor payments BANKS, etc Net saving (S)

12. The circular flow of income Investment (I) Consumption of domestically produced goods and services (Cd) Factor payments GOV. BANKS, etc Net taxes (T) Net saving (S)

13. The circular flow of income Investment (I) Government expenditure (G) Consumption of domestically produced goods and services (Cd) Factor payments GOV. BANKS, etc Net taxes (T) Net saving (S)

14. The circular flow of income Investment (I) Government expenditure (G) Consumption of domestically produced goods and services (Cd) Factor payments GOV. BANKS, etc ABROAD Import expenditure (M) Net taxes (T) Net saving (S)

15. The circular flow of income Export expenditure (X) Investment (I) Government expenditure (G) Consumption of domestically produced goods and services (Cd) Factor payments GOV. BANKS, etc ABROAD Import expenditure (M) Net taxes (T) Net saving (S)

16. The circular flow of income Export expenditure (X) Investment (I) Government expenditure (G) Consumption of domestically produced goods and services (Cd) Factor payments GOV. BANKS, etc ABROAD Import expenditure (M) Net taxes (T) Net saving (S) WITHDRAWALS

17. The circular flow of income INJECTIONS Export expenditure (X) Investment (I) Government expenditure (G) Consumption of domestically produced goods and services (Cd) Factor payments GOV. BANKS, etc ABROAD Import expenditure (M) Net taxes (T) Net saving (S) WITHDRAWALS

18. Economic Base Model Collapses All Spending into Regional and Non-Regional INJECTION Export expenditure (X) Regional Purchases of regionally produced goods and services Factor payments OUTSIDE OF REGION Import expenditure (M) WITHDRAWAL

19. Keynesian Cross Model

20. Export Base Model Adapted from Keynesian Cross Equilibrium Income Export Base Multiplier = $100/$20 = 5 or 1/m or 1/.2

21. http://www.rri.wvu.edu/WebBook/Schaffer/chap02.html http://www.fgn.unisg.ch/eurmacro/Tutor/keynesiancross.html

22. Basic & Non-basic • Basic is production for export outside the region • Non-Basic is production of goods and services for consumption inside the region • Population Dependent or Residentiary • Total Economy = Basic + Non-Basic

23. Export Multiplier • An injection (export sales) increases income in the area by an amount greater than the sale. • This export multiplier is computed (in the simple model) as 1/(Marginal Propensity to Import) • Imports = MPI times Income • Change in Exports times Multiplier = Total Change in Income • Multiplier is larger in a region that is more fully developed (higher non-basic to basic ratio)

24. Export - Led Growth • Growth of the Export (Basic) sector drives the economic growth of the region • Non-Basic Economic Activity is population dependent • Growth of Exports => Growth of Non-Basic (or Residentiary) Economic Activity • Economic Growth => Population Growth

25. Define the Region • Must Define Region • Evaluate trade flows & commuting patterns • Economic Region as defined by the Bureau of Economic Analysis • Place of Work • Place of Residence

26. Bureau of Economic Analysis (BEA) 2004 Redefinition of Economic Areas • Include: • New OMB definitions of MSAs (Feb. 2004) • Core Based Statistical Areas (CBSA) – urban core with populations of at least 10,000 • Metropolitan Statistical Areas (MSA) – have at least one CBSA with population exceeding 50,000 • Micropolitan Statistical Areas – smaller CBSAs • Combined Statistical Areas (CSA) – groupings of CBSAs that are economically interdependent • 2000 Census data – population and commuting • Documentation: • Johnson and Kort, “2004 Redefinition of Economic Areas,” Survey of Current Business, November 2004, http://www.bea.gov/bea/ARTICLES/2004/11November/1104Econ-Areas.pdf

27. BEA Economic Areas • Revised periodically (1974, 1977, 1983, 1995, 2004) • One or more economic nodes • Either Metropolitan or Micropolitan Statistical Areas • Regional centers of economic activity • Labor, product, and information markets • Primarily defined by commuting patterns • Serve as proxies for other markets • Newspaper readership data are used in less populated areas • Audit Bureau of Circulations for 2001

28. Basic Procedures: 3,141 Counties • Metropolitan and Micropolitan Statistical Areas are defined as nodes in the Core Economic Areas (CEA) • 344 Nodes • 1,311 Counties • Balance of counties (1,830) assigned to the 344 CEAs • CEAs aggregated to 179 BEA Economic Areas

29. 142: Salt Lake City-Ogden-Clearfield (Includes all Utah counties except Rich, Beaver, Iron, Washington, and Kane. Also includes Franklin, ID and Oneida, ID.) 92: Las Vegas-Paradise-Pahrump (Beaver, Iron, and Washington) 58: Flagstaff, AZ (Kane)

30. Defining Basic Industries • Agriculture • Mining • Tourism • Federal Government • Manufacturing (Partly)

31. Non-Basic Industries • Examples: Retail, Commercial, Banking, Necessities • As a region grows, it is able to support more non-basic employment • As a region grows, the ratio of non-basic employment to basic employment increases

32. Complications • Goods & services sold to visitors • Public transfers used by residents to purchase goods and services (e.g., old age, unemployment, agriculture, etc.) • Traditional basic purchases that are actually dependent on the level of regional activity (purchases by business travelers, etc.)

33. Basic Multiplier • (Total Employment) / (Basic Employment) • Total = Basic + Non-Basic • “Company Towns” in rural areas have a relatively small proportion of non-basic • Larger, more integrated and developed areas have much larger basic multipliers

34. Use of Multiplier • Estimates and projections of the base multiplier allow analysts to calculate impacts. • For example - if the basic multiplier for an area is two, this means that for every new job in the basic sector there will be an additional job created in the non-basic sector.

35. Units of Measure • Production • Final goods and services • Income • Value added • Employment • Full and part time job count • Sales Revenues • Double counting problem: wholesale & retail

36. Employment Measures • Most utilized in economic base estimation and projection • Reliable data source - ES202 • Over time • productivity changes alter the ratio of labor to output • ratio of income to jobs changes • multiple job holding changes

37. Growth Vs. Development • Economic Growth • Quantitative • More of the same • Economic Development • Qualitative • Structure changes • Technological • Market Changes

38. Why Do Regions Grow? • Comparative advantage => some industries locate in an area and others do not • Cost advantages • labor • materials • transportation • taxation / regulation • proximity to markets

39. Other Growth Factors • Forward & backward linked industries • Industry Clusters • Quality of life • Expectation of profit drives private capital investment decisions • Institutional context • Labor and capital mobility

40. Export Base Estimation • Industries are not necessarily 100% basic or non-basic. • The share of basic in an industry may change over time. • Industries evolve over time. • Structural change is difficult to model.

41. Industrial Classification • Old System: Standard Industrial Classification (SIC) • http://www.osha.gov/oshstats/sicser.html • Most recent revision: 1987 • New System: North American Industrial Classification System (NAICS) • http://www.census.gov/epcd/naics02/ • Introduced in the year 2000 • Most extensive and expensive revision ever • Will cause breaks in time series

42. Direct & Indirect Basic • Direct Basic + Indirect Basic = Total Basic • Direct Basic  exported out of the region • Indirect Basic sell to direct basic firms • Direct Basic + Indirect Basic = Total Basic • Direct Non-Basic + Indirect Non-Basic = Total Non-Basic (same logic)

43. Assumption Approachto Basic Sector Estimation • An industry may be assigned to basic or non-basic by assumption • Mining is often assigned 100% to basic • Local public schools are often assigned 100% to non-basic • Most industries are both

44. Location Quotient Approach to Basic Sector Estimation • Location Quotient = (Share of Subject Area’s Employment in Industry i) / (Share of Reference Region’s Employment in Industry i) • LQ>1 => Specialization • LQ>1 is not always basic (e.g., construction, local public school, etc.)

45. Basic Estimate: Location Quotient Approach bi = [(ei / Ei) - (et / Et)]  Ei bi : basic employment in local area industry i ei : total employment in local industry i Ei : national employment in industry i et : total local employment Et : total national employment

46. Location Quotient Approach bi = [(ei / Ei) - (et / Et)]  Ei Assumption: Local Consumption Share of Industry i’s production Local Share of Industry i’s production

47. LQ Approach Example bi = [(ei / Ei) - (et / Et)]  Ei 5 = [(2%) - (1%)]  500

48. LQ Calculation LQi = [(ei / et) / (Ei / Et)] 2 = [(10%) / (5%)]

49. Location Quotient Approach Logic If (ei / Ei) = (et / Et)  Self-sufficient  LQ = 1 If (ei / Ei) < (et / Et)  Imports  LQ < 1 If (ei / Ei) > (et / Et) => Exports  LQ > 1

50. Location Quotient Equation bi = [(ei / Ei) - (et / Et)]  Ei bi = [Ei  (ei / Ei)] - [Ei  (et/ Et)] bi = [ ( ei / et ) - (Ei / Et) ] et Industry i’s share of local employment Industry i’s share of national employment